Walter Energy: Down, But Not Out

After the market close on Wednesday, Walter Energy (WLT)reported earnings that beat estimates. The earnings this quarter were important considering the rapid decline of the stock over the last couple of months.

The company is a leading "pure-play" producer of metallurgical coal for the global steel industry with operations primarily in the U.S. and Canada.

The company reported a solid $0.43 from continuing operations compared to the $0.36 expected by analysts. Although production was up year-over-year, lower prices hurt earnings causing them to drop from last years $1.83.

Q2 2012 Earnings Highlights

Revenue declined 12% from 2011 though production increased to 2.91 MMTs from 2.67 MMTs last year. The main cause was an 11% drop in low-vol and mid-vol HCC pricing over Q1. Below are the earnings highlights:

Revenues of $678 Million; EPS of $0.51

Operating Income of $68 Million; EBITDA of $145 Million

EPS of $0.43 from Continuing Operations; EBITDA of $137 Million from Continuing Operations

Metallurgical Coal Production of 2.91 Million Metric Tons

Metallurgical Coal Sales of 2.84 Million Metric Tons

Partly off-setting the lower pricing were lower cash costs. For example, the US cash costs per MT in Q2 decreased to $107 per MT down from $119 per MT back in Q4 2011. This cost is expected further decline to $100 per MT by end of 2012.

Production Review

The company remains on schedule to hit the forecasted full-year guidance of 2012 met coal production between 11.5 to 13.0 MMTs. The company has produced just short of 6 MMTs in the first half and with several capital projects pulled, it will likely hit closer to the lower end of guidance.

Capital expenditures have been cut to just $150M for the rest of year. This is an average of $75M per quarter down from the nearly $125M averaged in the first half.

Stock Price

The stock has been decimated over the last year dropping from nearly $130 in August last year to the current price around $35. Naturally this price action matches the earnings decline, but the stock price hasn't been this low since the middle of 2009.

Valuation

The stock is currently difficult to value based on estimates that are unpredictable to estimate based on where met coal prices go over the next year. Analysts on average estimate over $6 in earnings in 2013 though those don't seem likely unless the market turns more robust next year.

After a couple of big earnings misses, the Q2 numbers at least provide more confidence that analysts will be able to more accurately forecast earnings going forward.

Conclusion

This stock remains cheap based on historical price fluctuations. The met coal sector is likely to remain very volatile where investors should look to make investment decisions when price action becomes extreme.

As the company mentioned, Europe is actually seeing an uptick in sales. To Walter management, this makes China the determining factor in global pricing. Not a big surprise to consensus thinking, but an investment in Walter Energy needs to be based on what happens to China demand.

The combination of China cutting interest rates, capital ratios, and adding stimulus and the low price of this stock suggests now might be the time to consider an investment. Walter Energy is well place with higher production and lower costs when the global market for met coal rebounds.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Please consult a financial advisor before making any investment decisions.